Equilibrium with a government sector
I + X + G = S + M + T
k = 1 / (MPS + MPM + MPT)
Sequence: closed 1/0.25 = 4, open 1/0.40 = 2.5, with government 1/0.50 = 2
Any question involving fiscal policy. G is an injection, T a leakage, and the leakage rate now has three components.
- G
- Government expenditure, an injection alongside I and X
- T
- Taxes, a leakage alongside S and M
- MPT
- The marginal tax rate, the share of extra income taken in tax
Sizing an expenditure-changing policy, and its external cost
required change in autonomous spending = income gap / k
induced change in imports = MPM x income gap
external cost per unit of fiscal action = k x MPM
Every Zone II and Zone IV question. The first line hits the internal target, the second measures the damage to the external one.
- income gap
- Full-employment income minus current income; negative for an inflationary gap
- k x MPM
- Deficit opened per unit of fiscal expansion, e.g. 2 x 0.15 = 0.30
Reading the Swan diagram
Vertical axis R (exchange rate) Horizontal axis D (absorption)
EE external balance, slopes UP
YY internal balance, slopes DOWN
Above EE surplus, below EE deficit
Above YY inflation, below YY unemployment
Zones anticlockwise from the left: I, II, III, IV
Any draw-and-explain question on internal and external balance. Name the axes first, then justify each slope, then the zones.
- F
- The intersection of EE and YY, where both balances hold
- Zone I
- Left of F: surplus with unemployment
- Zone III
- Right of F: deficit with inflation